What impact could this round of Russian retaliatory sanctions have on Europe?

In our continuing effort to bring increased transparency to the murky issue of sanctions we’ve compiled some initial thoughts on the likely Russian retaliatory response to the EU’s latest sanctions – published in full here and which we already analysed in detail here.

There are a few key measures which Russia is said to be considering:

1. Banning or limiting the import of cars (and possibly all automobiles) from Europe.
2. Banning or limiting the import of certain manufactured goods.
3. Banning or limiting the import of certain types of clothing manufactured in Europe.
4. Restricting the access of European flights to Russia airspace, probably over Siberia.

With the previous round of Russian retaliation we saw uproar from the industries involved and some questionable claims for compensation – a process which now looks to have been halted. The response also seemed to weigh on the minds of certain countries, such as Finland and Czech Republic, which in turn played a role in delaying the latest round of sanctions.

With that in mind its worth delving into what impact these mooted measures could have.

In terms of exports of cars, Russia remains quite an important destination for European exports as the graph above from the European Automobile Manufacturers Association shows. In 2012 Russia accounted for 8.1% of EU exports in this sector in terms of value – around €8.7bn. Ultimately, the impact will depend on exactly how the sanctions are structured – we doubt Russia would ban all exports of cars, it could be focused on only used cars or certain types or price brackets. In terms of countries which would be hit the obvious answer is Germany, but other countries such as the UK, France, Belgium and Spain could feel the pinch (albeit on a much smaller scale). Its also important to remember that, even without any sanctions we are already seeing a sharp fall in the level of cars being exported to Russia.

The story for clothing is similar. Russia remains quite an important export market for EU members, with exports to Russia totalling €3.185bn in 2013, making it the second largest destination for exports of EU clothing (graph above from European Fashion and Textiles Export Council). Meanwhile, as the graph below shows, the main countries exposed are Italy and Germany. This area could be particularly sensitive since we have already seen companies such as Adidas warning that the ongoing hostilities between the EU and Russia could severely hamper its business.

Comparing this to the previous round of retaliation, the figures do look a magnitude larger, although it does ultimately depend how broad the sanctions are and how long they last for. The potential sanctions on manufactured goods remains too vague to really assess, however, we can look a bit deeper into the airspace issue.

As the data to the left from FlightRadar24 (compiled by Bloomberg) shows there are lots of flights which use Russian airspace. This map from the Times, highlights that having to fly around Russia would be no small inconvenience and would certainly increase fuel costs and flying times.

So how likely are all these sanctions?

The feeling in Russia seems quite hostile this time around, compared to previously when they have more or less shrugged off the sanctions. This could be because Russia had hoped the ceasefire process would appease the EU, not least after the delay. Furthermore, the EU’s decision to target Rosneft, a key player in the energy market, may be seen as crossing a rubicon, since large energy firms had been largely off limits.

That being said, in the longer term, Russia probably has more to lose out from economic sanctions. Take for example the airspace ban – European firms pay around $185m per year for access to this airspace. Russia would also have to spend additional funds to enforce and police its airspace. Furthermore, the number of Russian flights which use European airspace is far higher, meaning a tit-for-tat sanction in this area would be particularly painful.

Some retaliation seems inevitable but Russia will still need to be cautious of further escalating the growing economic divide with Europe.

Does Russia’s gas deal with China change things for the EU?

News just out is that Russia and China have finally signed a gas deal, the negotiations of which have been going-on for a decade. (As the picture above, taken from a Gazprom investor presentation showed, this is something Gazprom has been targeting).

This is a pretty surprising turnaround given that every news outlet was reporting overnight that Russian President Vladimir Putin had failed in his attempts to finalise the deal in his current trip to China which ends tonight.

The key points of the deal are follows:

• The contract will be over 30 years and is unofficially estimated to be worth $400bn (19% of Russian GDP).

• It will see Gazprom supply up to 38 billion cubic meters (bcm) of gas to China per year from 2018. Once further pipelines are complete, this could be expanded to 61 bcm per year. As a comparison, over the past four years Gazprom has exported an average of 157 bcm per year to Europe (including Turkey).

• No official price has been revealed but the biggest sticking point has been that China believed Russia’s price demands were too high. It will be interesting to see if Russia gave in on this point.

• This deal has proved increasingly important for Russia as it looks to shift it’s away from relying on European demand for its energy exports.

What does this deal mean for the EU?

• In the short term, not too much. The economic links between Russia and Europe will continue to be significant and they will continue to be reliant on each other when it comes to energy (the former to sell the latter to buy).

• The deal will not be in place until 2018 and even then will only see Russia selling a fraction of its gas exports to China every year, exports to the EU could still well be two to four times the size.

• For these reasons, it is unlikely to change the potential impact which EU sanctions would have on Russia. Although of course Russia remains relatively unconcerned by such threats when it knows of the huge divides within the EU on the issue.

• All that said, it is symbolically important and could have longer term impacts. It highlights Russia’s desire to move away from links with Europe. Combine this with Europe’s desire to increase energy security and the relations between the two sides could become increasingly cold and distant. Although, some countries due to geographical proximity (Bulgaria/Hungary) or due to long standing economic links (Germany) will surely continue to have good relationships with Russia.

• It also raises questions over future tie ups between Russia and China. Areas such as payments systems, broader financial markets, transportation and machinery have all been touted as sectors for potential cooperation between the two countries. Again while a long term issue, such ties up may concern the West since Russia and China are currently reliant on their exports in many of these areas. Both the EU and US will need to figure a clearer policy for how to deal with such changes, with the EU in particular in need of updating its policy towards its eastern neighbourhood.

Unintended consequences: could tariffs on Chinese imports actually harm the EU's solar panel industry?

The past few weeks have seen a marked increase in hostilities between China and the EU over the ongoing trade dispute, centred on the solar industry. Given that it’s between two of the largest economies in the world, this dispute is not to be sniffed at.

As the WSJ noted last week, the Chinese government has increased its rhetoric against the recent EU trade investigation in illegal subsidies to solar panels imported to the EU from China, while the threat of similar action on telecommunications is deepening the divide. Tensions peaked over the weekend with the Chinese delegation to the EU putting out a press release containing a veiled threat of retaliation if the EU pushes ahead with tariffs and other protectionist measures.

Below we lay out some background and key points on the solar panel case which is driving the dispute.

So what's going on here?

• To recap, last September, DG Trade at the European Commission launched an anti-dumping investigation into whether imports of Chinese solar panels and their components were being given unfair subsidies by the Chinese government. The investigation was launched after a complaint by EU ProSun, a collective of European solar firms. This group is led by the EU’s largest solar firm Solar World. Solar World was instrumental in pushing similar action in the US (which also instituted tariffs).
• DG Trade has announced that imports of Chinese solar panels will face tariffs of between 37.3% to 67.9% from 6 June 2013, although the exact amount will vary from firm to firm (until that date the ruling can of course be altered). This ruling is temporary and the duties are provisional since the investigation (and other similar ones) are still on-going. Once the investigation is complete the findings are presented and the issue is put to the Council of Ministers for a vote on whether to impose permanent duties.

There are a lot of different legal, economic and political points to consider here.  It is clear that the Chinese firms are receiving significant subsidies and by the letter of the law there should probably be some tariffs.

However, this episode obscures a much more fundamental point: the EU’s solar panel market is to a large extent unsustainable. In the early 2000’s Solar firms were given significant subsidies, especially in Germany, and were able to expand rapidly despite being barely commercially viable. Once the eurozone crisis hit, and governments had to start cutting spending, the subsidies dried up.

Ironically, cheap imports from China are likely to have played a significant role in supporting this market as public subsidies in Europe wound down (by helping to bring down production cost). Similarly, given the variety of cheaper options available, solar cannot yet be commercially competitive without some form of government support – be this directly from Europe (which cannot afford it at the moment) or indirectly from China. So, again, ironically, there's a risk that the tariffs contribute to killing off Europe's own solar market - raising questions about the Commission's claim that the tariffs are needed to protect 25,000 European jobs.

This is also a classic example of large firms using their market position to lobby the EU to take action to lock in the status quo. Larger firms such as Solar World are keen on the tariffs and/or other protectionist measures while smaller firms (that are looking to partner up with and import cheap components from Chinese firms) are reluctant.

Finally, whilst the Chinese government isn't exactly whiter than snow, the EU must be very careful not to trigger a trade war - not only would it be economically damaging, but the EU's trade image would also be seriously damaged.

Finding a compromise should be the short term goal, but over the longer term it poses an interesting question over how national policies impact other countries (see also the prospects for currency wars) and what can be done to manage this. This dispute should also force the EU to consider its position on heavily subsidised markets which are very rarely viable over the medium and long term.

So, what next? The dispute is likely to continue, although a statement last night by EU Trade Commissioner Karel De Gucht did show some signs of conciliation. A decision on whether to impose the temporary tariffs will be needed by the 5 June - if they are imposed then the dispute could escalate quickly. These would run until December when the investigation is complete at which point the findings and prospect of permanent tariffs would be put to the Council of Ministers.

Would an 'independent' UK get a better US trade deal than the EU?

Could the UK sucessfully negotiate a trade deal with the US?

Yesterday MEPs voted on a resolution to back defensive measures to exclude cultural and some agricultural products, such as genetically modified foods from a proposed free trade deal with the US (TTIP).

Understandably US farmers have already taken exception to what they see as EU protectionism. This raises concerns that the potential gain from an EU/US trade deal may be watered down, delayed or even blocked all together by vested interests on both sides of the Atlantic.

As a member of the EU the UK's foreign trade is governed by the EU's common commercial policy and so has to be done via an EU deal. After the EU the US is the UK's most important trading partner. Some involved in the UK-EU debate - particularly Outers - suggest that if the UK left the EU it could negotiate a deal with the US on better terms than it could potentially gain via the EU. But is that the case? Here are some of the factors that could be important.

UK exports to the US in £bn (ONS 2011) are big...

A mismatch in negotiating power. Although the UK exports a lot to the US, as a % of it's total exports, the US sends only 4% to the UK. So although a trade deal should be mutually beneficial, reaching a solution would be disproportionately in the UK's interests. Therefore, there would be an imbalance of negotiating power. For this the EU's weight could help on issues where the UK's interests are aligned with it.

Would the US want to go through the hassle? Given this asymmetry, and the relative small market the UK is for the US, one question is if the US would go through all the political hurdles -  approval in Congress, taking on the unions etc. Indeed, talk to people in Washington and there's some scepticism about this. (However, the US has signed agreements with 23 states, some very small, so perhaps it is more a matter of the terms you would get?)

But US exports to UK (US BEA 2011) are small...

Fewer protectionist hold ups. At the same time, the US and the UK are more compatible economies than are the US and EU. The UK negotiating on its own account would not be hindered by protectionist issues emanating largely from France and MEPs, that could hold up US agreement or require concessions, such as the protection of agriculture, genetically modified foods or geographical indicators. However the UK is still unlikely to wish to see the US allowed to subsidise its agricultural exports, so tough negotiations would still be required.

Access for financial services could be a tough negotiation. The UK negotiating with the US on financial services would come up against a powerful US lobby attempting to protect its banks from what is New York's main rival - London. However, the UK negotiating on its own would arguably have a better chance to strike a deal on 'reciprocity' with US funds, a more generous arrangement than that which currently exists under regulations such as the AIFM Directive or UCITS. Additionally the UK would not bear the burden of having risky eurozone banks getting in on the deal. In recent negotiations with Singapore the US gained a better deal than the EU on financial services, partly because while Singapore was happy with UK banks it was wary of giving access to all eurozone banks (a big untold story in all of this).

If the idea is that an 'independent' UK can automatically join some gigantic Transatlantic free trade zone, in place of its current EU membership, there will be plenty of hurdles and a good deal is by no means guaranteed. Added to that there's also the small matter of negotiating an equivalent free trade deal with the EU....

New ONS Figures show the trade deficit with the EU is widening - but total volumes show the EU market is still important

The ONS has today released its latest monthly UK trade statistics. They show that despite growing UK trade and a slight narrowing of the trade deficit, the problems in the eurozone are still hampering UK exports to the rest of the EU.

Here’s some extracts from the UK's ONS bulletin of the 1st quarter of 2013:

The value of UK exports increased by 3.5% between February 2013 and March 2013. The value of imports increased by 2.6% over the same period.

The widening of the deficit with the EU in the first quarter came mainly from trade with Germany and the Netherland. Outside the EU, the UK’s surplus in trade with the US improved by around £1.1 billion in the first quarter, largely due to a recovery in exports.

Within EU countries, imports from Belgium & Luxembourg increased by £0.4 billion and imports from Germany increased by £0.1 billion.

Within EU countries, exports to Germany decreased by £0.3 billion.

So in general UK trade is up but exports to the EU are down. The decrease in UK exports to the EU has increased the UK's deficit with the EU as eurozone states have managed to increase their exports to the UK - if not to each other.



UK trade in goods the EU remains at 50%

So what conclusions can we draw from this?

Firstly, although the EU remains a vital market for UK goods the eurozone crisis has led to a diversification into other markets.

Secondly, the eurozone crisis has let to a widening in the UK's EU trade deficit. This appears to be due to a  fall off in eurozone demand for UK exports combined with a continued appetite in the UK for EU goods.

However, it is important to note these figures are for goods only. As we set out in our report Trading Places the picture for the UK's services exports differs substantially. The UK has a world class services sector that produce a substantial trade surplus. The best growth markets for this sector is undoubtedly in the growth markets outside the EU. For UK services, as long as the EU remains a fragmented market the relative merits of doing business in the EU over other global markets are small. All the more reason to push on with EU Services liberalisation as we propose here.

IMF sees a mixed outlook for Europe - calls for more ECB action and a fiscal union

The IMF today released its latest World Economic Outlook forecasts. As usual the forecasts are not overly different from the previous ones - published in October last year - but there are a few interesting points.

The map above gives a pretty good feeling for just how bad Europe is doing relative to the rest of the world at the moment (click to enlarge).

The IMF warns about the risks of complacency and lack of  implementation of reform and austerity measures in the eurozone, something we touched on here:

Amid reduced market pressure and very high unemployment, the near-term risks of incomplete policy implementation at both the national and European levels are significant, while events in Cyprus could lead to more sustained financial market fragmentation. Incomplete implementation could result in a reversal of financial market sentiment. A more medium term risk is a scenario of prolonged stagnation in the euro area.

This seems to be clear reference to the banking union and the creation of a cross-border resolution mechanism to deal with banking crisis such as the one seen in Cyprus. This is a valid concern - there is huge uncertainty over the banking union.

The IMF also notes that while current account adjustment has been progressing in the eurozone it is not clear whether it is simply cyclical or the result of deeper reform:

Current account balances of adjusting economies have improved significantly, and this improvement is expected to continue this year. This increasingly reflects structural improvements, including falling unit labour costs, rising productivity, and trade gains outside the euro area. But cyclical factors also play a role, notably layoffs of less productive workers, and would reverse with eventual economic recovery.

Further to that point, there is also the interesting table below showing that Greece, Ireland and Spain have had some success in reducing unit labour costs (change is difference between the dot and the diamond). Greece mainly through cutting labour costs but the others also through increasing productivity. But there is some way to go yet, while countries such as France and Italy have made little to no adjustment. It's also worth keeping in mind that, while Portuguese ULCs have fallen from their peak, the trend and some of the fall has now been reveresed.

In addition, there are continued signs of a split in policy approach between Germany and the IMF. Comments such as these are unlikely to go down well in Germany:

Room is still available for further conventional easing, as inflation is projected to fall below the European Central Bank’s target in the medium term.

Greater fiscal integration is needed to help address gaps in Economic and Monetary Union design and mitigate the transmission of country-level shocks across the euro area. Building political support will take time, but the priority should be to ensure a common fiscal backstop for the banking union.

We'd have thought, after three years of being exposed to the politics of the troika, the IMF might be a bit more sensitive to the political intracacies of the eurozone crisis. However, it does highlight that the fundamental choice facing the eurozone has not gone anywhere..